Johnston Processors Limited

Charlie Johnston, President of Johnston Processors Limited, operators of three One Hour Drycleaning franchises, sat in his office in downtown St John's and considered the information in front of him. It was March 28, 1991, and Charlie's accountant, Harry Wood, had just presented him with a draft copy of his financial statements for the year ended January 31, 1991. "This indicates that we've experienced another decrease in sales and profits," Charlie commented. "Obviously, our bankers win not like this situation at all; they may even decide to call our term loans. This would have a severe negative effect on my other companies. As you know, my wife, Marie, and my daughter, Christina, operate this company. We'll have to analyze this company's situation further to see where our problems are and what can be done to solve them." Harry, of Wood and Smythe, Chartered Accountants, nodded in agreement. "Unfortunately, we won't be able to do the analysis for you. As a small, independent firm, our personnel resources are stretched to the limit at this time of year. Why not ask someone from the University's Small Business Centre to conduct this study?"


This case was prepared by Professor Wayne King of Memorial University of Newfoundland for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management. Some elements of this case have been disguised.

Copyright 1992, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.


Background Information

Charlie Johnston was the operator of several small companies in the Avalon Peninsula region of the Province of Newfoundland and Labrador. Over the years Charlie had been moderately successful, and had, in fact, accumulated considerable personal wealth, primarily as equity in various companies. Charlie's wife, Marie, was a nominal shareholder in most of Charlie's companies, but with the exception of the drycleaning franchises, did not play an active role in management. "When the kids were younger, I felt more comfortable working at home, raising our family," Marie recalled. "However, when Christina, our youngest daughter, finished high school, I found I had sufficient time to make a contribution to the businesses. Originally, I wanted to become involved in some of the existing companies, but they already had management people in place and were operating smoothly. As well, Christina was having difficulty in finding employment. Charlie and I decided that we would look for a new opportunity for Christina and me to start up."

The Johnstons' determined that a franchise arrangement would be the most suitable for Marie and Christina. They felt that franchises had several advantages, including recognition by customers, national advertising, assistance with store design and location, and advice in other areas if necessary. The disadvantages were the high initial franchise fee and the relatively expensive royalty and advertising payments required by the franchise agreement. In 1982 the family spent several months reviewing the 'Business Opportunities' sections of several business magazines and newspapers. They decided to proceed with the acquisition of a 'One Hour Drycleaning' franchise, a self-contained drycleaning store designed to operate from a shopping mall. "We felt that the concept was logical," Marie commented. "A customer could drop off cleaning, shop for a while, and then pick up the cleaned clothes on the way out." Later in 1982, the Johnstons opened their first store in St John's largest shopping center. The stores were relatively expensive to establish; the initial franchise fee was $40,000 per location, equipment cost approximately $165,000 and leasehold improvements of $75,000 were required. The opening balance sheet of a single location as required by the franchiser is presented in Exhibit 1.

Over the next four years the company prospered. Two years after the first store was opened, a second store was set up at the other large mall in St John's. A third store was started about a year after that, also in St John's. As was typical of many small business operators, the Johnstons' cash was invested in their companies. For that reason, the shareholders' advances consisted of funds borrowed personally and invested in the company, with the interest charges paid through the company account. As a result, the shareholders' advances did not provide a cushion which would assist the company in periods of slow business activity. Instead, the shareholders were dependent on the company to cover these interest charges even in poor periods.

Shortly after the opening of the third store, the company's performance began to deteriorate. Several reasons for this were advanced by Marie Johnston. "First, we can't seem to hire people who care about working any more. Consequently, our turnover is high. just as we get our employees trained to operate the machines, they leave to work at one of our competitors. Also, we have been having trouble with the machines. The manufacturer has no local repair or parts service, so even minor problems can create delays in satisfying customers' orders. We also have more competition. Presently, there are more cleaners in town than ever before. In fact, the operator of the mall where our first and biggest store is located has just allowed one of our competitors, which had a drop-off location there, to install a service somewhat similar to ours. We complained, but there doesn't seem to be much we can do about it."

About a year ago, the Johnstons had been approached by two separate groups who expressed an interest in acquiring one or more of the stores. The first inquiry was from a group of local investors who bought and sold small companies as investments. The second was from an individual who had spent more than 20 years managing a cleaning store for an owner who did not spend much time with the business. This individual had decided to investigate the possibility of acquiring his own store. At the time of the inquiries the Johnstons were not interested in selling, however, Charlie, in particular, was beginning to wonder if this option might still be open. "Interest rates have been falling for some time now. This will help make it easier for prospective buyers to meet their financial commitments. As well, the overall market for drycleaning services is increasing annually through inflation."

Organization

Although Charlie Johnston was listed on the company's records as President, he actually had little contact with it, except to review the monthly sales reports, and to negotiate lines of credit with the company's banker. Marie, as Vice-President, was in charge of the day-to-day operations, assisted by Christina, who worked full time at the stores. The accounting was done by a bookkeeper, Valarie Anthoney, who worked at Charlie's office and maintained accounting records for several of his companies.

One of the Johnstons' areas of concern was the management reporting system. The accounting for the store was done using a hand-written system, consisting of sales, cash receipt, purchase and cheque disbursement journals. Subsidiary ledgers could be prepared for accounts payable and accounts receivable. Valarie described the system as, "a really convenient way to maintain a complete set of records. We only use the Accounts Payable system here because all of our sales are for cash. Mr. Johnston sometimes complains that he doesn't get enough information, but I give him a monthly list of Accounts Payable and a Monthly Sales Summary for each store. Apart from that, I really can't provide him with anything else."

Marie Johnston originally saw her role in the organization as being in the policy area. However, this had changed recently "We've had some very difficult decisions to make here in the past two to three years," she said. "Unfortunately, because of the decline in sales, we've had to insist that employees pay for their own uniforms. We've also been unable to adjust wages, except to keep pace with minimum wage movements. We laid off our store managers about a year ago, again for cost-cutting reasons. Since then, Christina and I have spent most of our time going from store to store to ensure things are running smoothly."

The Problem

After the meeting with his accountant, Charlie called a meeting with Marie and Christina and discussed the options available to them. Marie and Christina were positive about the stores and their ability to effect a turnaround. "We are the ones who know the business first hand," said Marie. "I feel that if we spent some money upgrading the stores' appearance, which we have had to allow to deteriorate somewhat, and in overhauling the equipment, we will attract our customers back. We should also increase our advertising." "I'm not so sure," replied Charlie. "We've already invested a substantial amount of our own funds in these stores. Maybe we'd be throwing good money after bad. Besides, our national advertising expenses are already pretty high. I really have no idea whether there is enough business out there for us to be successful. Perhaps I should check to see if the potential buyers from last year are still interested."

The Alternatives

After further discussion, the Johnstons summarized their options as follows:

  • invest an additional $40,000 of personal funds in the stores to upgrade the appearance and equipment;
  • increase bank borrowing by $40,000 for the same reason;
  • sell one or more of the stores;
  • close one or more of the stores.

At the Johnston's request, Valarie and Harry prepared a statement of income for each store for the most recent financial year. In addition, financial statements for the past three years were collected. Also, Marie prepared what she felt were reasonable operating forecasts to support her contention that an additional investment was justifiable. (Exhibits 2 to 6). Charlie was anxious to have the data analysed and looked forward to the report from the Small Business Centre.


Exhibit 1

One Hour Drycleaning
Forecast Opening Balance Sheet
(One Location Only)

Exhibit 2

Johnston Processors Limited
Statement of Income
For the Year Ended January 31, 1991

Exhibit 3

Johnston Processors Limited
Forecast Income Statements
For the Years Ended January 31, 1992 and 1993

 exh17.jpg (29888 bytes)

Exhibit 4

Johnston Processors Limited
Statement of Income and Retained Earnings
For the Years Ended January 31, 1988-1991

Exhibit 5

Johnston Processors Limited
Balance Sheet
As of January 31, 1988-1991

exh20.jpg (11770 bytes)

Exhibit 6
One Hour Drycleaning Limited
Selected Target Ratios

Current ratio 2 :1
Quick ratio 1 :1
Inventory Turnover 15
Debt ratio 75%
Return on assets 5%
Return on shareholders' equity 20%
Times interest earned 6
Gross profit percentage 65%